Economy's new test: Spending vs. saving

Millions of American consumers helped spend the economy back to a decent pace of growth in the last few months.

But some of them did so against their own long-term self-interest. That could be you, if you temporarily gave up on the idea of saving any money, opting instead to head to the mall, the car dealer or Las Vegas.

The fourth quarter reversed some of the progress the country has made since 2007 in boosting the personal saving rate, the government's measure of the percentage of income people hold back as savings in one form or another.

The saving rate slipped to 5.3% in December, down from 6% in August and the lowest since last March.

The latest number still was vastly improved from the depths reached last decade, when the rate briefly fell below 1% — emblematic of the nation's spendthrift ways in that era.

But the recent decline in people's ability or willingness to save stirs fears that we're reverting to the bad old days, failing to do enough to build adequate financial cushions for the inevitable future shocks.

Of course, we know where the Federal Reserve stands on the issue. By keeping short-term interest rates near zero, Fed policy is squarely aimed at encouraging consumption.

If you're trying to decide between adding cash to a bank account or having a nice dinner out, "the reward for postponing spending is not very high," said Paul Kasriel, economist at Northern Trust in Chicago.

The Fed clearly is not interested in testing the "paradox of thrift": If too many of us were to slash consumption to boost our saving rates, we'd risk pushing the economy back into recession.

Luckily for the Fed and the economy, for the last two years a saving rate mostly between 5% and 6% has produced a reasonably happy medium, meaning enough spending to drive a recovery while also allowing at least some portion of households to fund larger nest eggs.

"Many people are being very cautious" about their finances, said David Wyss, chief economist at Standard & Poor's in New York. "Whether they're being cautious enough is the question."

The way the government measures the saving rate is simplistic, which is to say it's imperfect. The Bureau of Economic Analysis adds up gross personal income each month (wages, interest, etc.), subtracts taxes, then subtracts gross personal spending (on food, shelter, services, etc.).

What isn't spent is presumed to be saved ... somewhere.

One weakness of the government's methodology is that it can overstate spending on big-ticket items and thus understate the saving rate. A big jump in car sales — which is what we had in the fourth quarter — can depress the saving rate because those sales are counted as if they were an instant expenditure at the full price of the vehicle. Yet many are paid for over time.

But another common criticism of the saving rate in the 1990s and last decade isn't heard much anymore: the fact that it fails to take into account other accumulated savings, such as real estate appreciation and capital gains on stock holdings.

The idea that a low saving rate didn't matter usually was put forth by people who believed that Americans didn't have to save much from their paychecks because their homes and their investment portfolios were saving for them.

We all know how that worked out. For many families, the housing market collapse that began in 2006 obliterated the home equity that was their primary nest egg. Then came the financial crash of 2008, which devastated even blue-chip stock holdings.

That double whammy was beyond anything most people ever could have imagined. "We've never had wealth destroyed to that degree," said David Rosenberg, chief economist at investment firm Gluskin Sheff & Associates in Toronto.

The Fed calculates that American households' collective net worth — assets minus debts — crashed 24% from the end of 2007 to the first quarter of 2009.

The total climbed back to $54.9 trillion as of last Sept. 30 but still was down 14.5% from $64.2 trillion in 2007.

Given the frightening wipeout of wealth, it would have been shocking if the saving rate hadn't risen over the last two years. But the number overall masks the obvious harsh reality: Although some people are saving as much as they can, others are saving nothing, either by choice or because they're unable to make ends meet with their income.

An Investment Company Institute survey late last year of 2,039 households that own financial assets found that just 18% of those with annual incomes below $30,000 had increased their saving rate in the previous three years, while 39% saved less and 43% held steady.

By contrast, 38% of households earning more than $100,000 said they'd been saving more, while just 14% said they'd saved less.